How to Benefit from the New Tax Law

"There is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everyone does so, rich or poor; and all do right, for nobody owes any public duty to pay more tax than the law demands." -Judge Learned Hand

The recent tax cut package passed by Congress contains some significant tax relief for investors. I've highlighted three of the key provisions of the new law below along with some guidelines to help you benefit from its investment implications.

1. Income tax brackets have been ratcheted down. For example, the top marginal income tax rate has been reduced from 38.6% to 35%.

Advice: You'll owe less federal income tax this year. Consider contributing this excess cash to your investment accounts.

2. Taxes on long-term capital gains have been reduced from 20% to 15%.

Advice: Capital gains are only taxed in the year that they are realized (that is, when you sell an investment that has gone up in value). If you have owned the asset for less than a year at the time of sale, your profit is classified as a short-term capital gain and is taxed at your ordinary income tax rate (35% in the top bracket). This is a huge difference from the 15% capital gains tax on assets held more than one year. You can avoid the higher tax by paying close attention to your buy and sell dates. Whenever possible, you should refrain from selling a security at a profit if you've held it for less than one year. If you do incur a realized gain, you can still eliminate the tax liability by taking an equal or larger loss in another holding.

3. Dividends, which were previously taxed at your ordinary income tax rate, are now taxed at 15%.

Advice: Before the new tax law, it was clear that high dividend-paying securities (such as utility stocks and REITs) belonged only in tax-deferred accounts. Although the penalty for keeping these assets in a taxable account has been reduced (to 15%), it has not been eliminated. Therefore, it is still advantageous to minimize your tax liability on dividend-paying securities by keeping them in a tax-deferred account, when possible.

The great thing about tax-efficient investing is that it is guaranteed to put more money in your pocket. However, it requires careful record-keeping and a working knowledge of how your investments are taxed. If you've got more important things to worry about, we are happy to put our tax-smart investing strategies to work for your portfolio.

July 2003

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